Thomas Piketty and the Foreign-Investment Question

For years, development economists have suggested that, when companies from the developed world invest in poor countries, it helps to mitigate international inequality. Early in his book “Capital in the Twenty-First Century,” the economist Thomas Piketty expresses skepticism about this idea. The owners of corporate assets tend to pocket most of the income generated by those assets, he points out, so a foreign company operating in a poor country levels the field about as much as a rich person opening a sweatshop in a slum. He writes:

None of the Asian countries that have moved closer to the developed countries of the West in recent years has benefited from large foreign investments, whether it be Japan, South Korea, or Taiwan and more recently China. In essence, all of these countries themselves financed the necessary investments in physical capital and, even more, in human capital, which the latest research holds to be the key to long-term growth.

It’s clear that Piketty admires governments that encourage domestic companies to produce products and provide services. Typically, these governments also educate an élite group of potential managers and scientists, acquire (or ignore) licenses and patents, and organize capital to fund domestic firms. And they insist that foreign companies looking to do business enter into joint ventures with domestic partners.

Those who advocate for this method as a better alternative to foreign investment seem to assume that a company’s assets are made up primarily of physical stuff; Piketty, for his part, defines corporate capital as “land, dwellings, commercial inventory, other buildings, machinery, infrastructure, patents, and other direct owned professional assets.” But there’s a problem with this assumption. Capitalism isn’t really about physical property—not anymore. In fact, in the twenty-first century, intangible assets, such as the knowledge shared by employees, dwarf physical holdings. (Elsewhere in the book, Piketty acknowledges that a company’s value is also determined by the knowledge contained within the corporation, not just its patents but “its information systems and modes of organization.”)

“Capital in the Twenty-First Century” is studded with charts illustrating changes in commercial life over the past century. (On Friday, Chris Giles, in the Financial Times, questioned some of the data regarding how inequality has changed over time.) But Piketty doesn’t include any charts showing the growth of intangible assets in major global corporations over the past several decades. The trend can be seen, vividly, in this chart. It shows, over time, how much of the combined market cap of companies on the S. & P. 500 could be attributed to intangible assets rather than tangible ones:

In 1975, about twenty per cent of companies’ valuations could be attributed to intangible assets, such as knowledge; by 2007, the proportions were reversed. This is not a small change, as the business professors Baruch Lev and Robert Kaplan, among others, have noted. It coincides with advances in information technology, whose effects economists are only beginning to understand. (Piketty writes that the “US economy was much more innovative in 1950-1970 than in 1990-2010, to judge by the fact that productivity growth was nearly twice as high in the former period as in the latter.” But, for various reasons, some of which John Cassidy detailed in a post last year, data on productivity is an incomplete, and possibly inaccurate, gauge of innovation.)

Changes in the makeup of corporate assets matters, in particular, when discussing international inequality. The gap between rich and poor countries is between knows and know-nots, not just between haves and have-nots. It used to make sense to assume that, once a domestic business owned material assets, it wouldn’t need a very high learning curve before it was working more or less profitably. But, while that outlook worked for products like soap, it doesn’t hold up for something like smart phones: virtually anyone with a factory, a recipe, and cheap labor can make soap, but building smart phones requires knowledge. Piketty understands the change, at least in principle. He writes that poor nations catch up with rich ones “to the extent that they achieve the same level of technological know-how, skill, and education,” which is “often hastened by international openness and trade.” But is trade alone enough to engender learning?

This is where foreign direct investment can be useful, if not indispensable. To profit from their investments abroad, global companies must deploy and increase intangible assets, partly by educating the people with whom they work locally—employees, business partners, and so on. Foreign companies introduce new production methods and management standards, and train local workers to enact them. They also introduce employees to a global network of suppliers and customers, crucial marketing knowledge for startups. In other words, foreign direct investment involves implanting intellectual capital, not just appropriating financial capital. (There’s a spectrum, of course. A consumer-electronics company, for instance, will typically do more of this than a mining company.) Without help, local entrepreneurship is much more difficult.

Motorola’s investment in China is one case with which I have intimate knowledge. (I consulted for the company from 1995 to 1997.) In 1986, Motorola was the world’s leading maker of infrastructure, handsets, and semiconductors for cell phones. Chinese officials were pushing Motorola to create a joint venture with Panda, China’s crippled electronics company. In an early analysis of China, Motorola decided that there were enough customers in the country to sell a hundred and fifty thousand handsets and twenty-seven thousand pagers—not enough to justify a manufacturing investment of any scale. But Motorola’s C.E.O., Robert Galvin, saw through the numbers, largely because the company’s subsidiary in Israel had been so successful. He supposed that other major global companies would soon invest in China, and expected that their infusion of intellectual capital would catalyze enormous growth—and, with it, new demand for telecommunications infrastructure.

So Galvin dared Chinese officials to allow Motorola to open the country’s first wholly owned subsidiary, arguing that sharing management responsibilities with local venture partners, run mainly by political appointees who knew nothing about advanced technology-production processes, would wreck the project. In return, he committed to building a production facility (exactly like one owned by Motorola north of Chicago), train local managers, and open an advanced semiconductor plant. The Chinese government, having just issued more liberal conditions for foreign investment—the famous “twenty-two points”—warily agreed. (Motorola semiconductor executives were also wary; they were concerned about Chinese semiconductor companies learning their methods and becoming competitors.)

In 1989, Motorola began building a “world-class” production facility in Tianjin. The company also founded an executive-training program; the curriculum first had to teach Chinese trainees, traumatized by the Cultural Revolution, how to speak their minds (the opposite, I might add, of what needed to be taught in Israel). The semiconductor plant, and the transfer of manufacturing technology, went ahead, too. By 1995, Motorola had two billion dollars in sales in China.

That Motorola is gone. The company was late to adopt digital cell-phone technology, and found itself struggling by 2000; the executives who had worried about Chinese knockoffs should have been worrying about advances at Nokia. Motorola finally sold its consumer mobile business to Google, in 2011; a year later, Google sold the Tianjin manufacturing facility to Flextronics, a company based in Singapore. But Tianjin is now a manufacturing and design hub for thousands of companies, both foreign and domestic. It is also China’s fourth-biggest city and has the country’s highest G.D.P. per capita, of nearly fourteen thousand dollars. Motorola’s impact on Tianjin was a lot more like M.I.T.’s on Cambridge, in the eighties, than United Fruit’s on Guatemala, in the fifties. The same could be said for Volkswagen in Mladá Boleslav, in the Czech Republic, or Honeywell, in Pune, India.

The good news—for Piketty and for everybody else—is that intellectual capital is not inherently scarce in the way that financial capital is. A global company does not give up technology or systems by sharing them, though, again, it might well lose the competitive advantages—and revenues—it gains from employing them. If I give you a dollar, I don’t have it anymore; but, if I teach you something, I don’t stop knowing it. The growing importance of intangible assets in itself might not mitigate inequalities, and might even exacerbate them, at least at first. But the role of intangible assets in foreign investment should inspire some hope that it could help reduce inequalities, too. In any case, this belongs in the conversation that Piketty’s book has, thankfully, occasioned.

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